required study

On July 20, 2012, the SEC delivered to Congress the report required by Section 106 of the JOBS Act, which directed the SEC to examine the impact of decimalization on IPOs and the impact of this decade-old change on liquidity for small- and mid-cap securities. Section 106 goes on to say that if the SEC determines that securities of emerging growth companies should be quoted or traded using a minimum increment higher than $0.01, then the SEC may, by rule, not later than 180 days following enactment of the JOBS Act, designate a higher minimum increment between $0.01 and $0.10. It doesn’t look like any such change is coming down the pike based on the Staff’s conclusions and recommendations in the study.

The study notes the observations of the IPO Task Force regarding the changing market structure and economics arising from the shift to decimal stock quotes, which point toward a negative impact on the economic sustainability of sell-side research and the greater emphasis placed on liquid, very large capitalization stocks at the expense of smaller capitalization stocks. The SEC’s study takes a three-pronged approach to examining the issues: (i) reviewing empirical studies regarding tick size and decimalization; (ii) participation in, and review of materials prepare in connection with, discussions concerning the impact of market structure on small and middle capitalization companies and on IPOs as part of the SEC Advisory Committee on Small and Emerging Companies; and (iii) a survey of tick-size conventions in foreign markets.

Not surprisingly, the Staff concluded that decimalization may have been one of a number of factors that have influenced the IPO market, and that the existing literature did not isolate the effect of decimalization from the many other factors. The Staff also noted that markets have evolved significantly since decimalization was implemented over a decade ago, and that other countries have utilized multiple tick sizes rather than the “one size fits all” approach implemented in theUnited States. Based on the observations reported in the study, the Staff recommends that the Commission should not proceed with specific rulemaking to increase tick sizes, but should rather consider additional steps that may be needed to determine whether rulemaking should be undertaken, which might include soliciting the views of investors, companies, market professionals, academics and others on the broad topic of decimalization and the impact on IPOs and the markets. In particular, the study notes the possibility of a roundtable where these issues can be addressed.

While the study does a nice job framing the debate regarding decimalization and its impact on the markets, it doesn’t move the ball forward appreciably in terms of potential for rule changes responding to the debate. We’ll have to wait to see how this all unfolds.

The JOBS Act directed the GAO to undertake a study concerning the factors impeding greater use of currently Regulation A. The GAO study examines trends in Regulation A offerings, noting that the number of offerings increased from 1992 through 1997. This increase followed the SEC’s changes to the offering ceiling for Regulation A offerings from $1.5 million to $5 million. Since 1997, however, the number of Regulation A offerings has declined. The study notes that issuers have tended to favor Regulation D offerings. The report cites a number of factors that likely have contributed to the lack of interest in using Regulation A for capital-raising. For example, the report cites the delays associated with the SEC review of Regulation A offering statements (whereas an issuer faces no disclosure requirements in connection with a Regulation 506 offering made to accredited investors) and, of course, the time-consuming and expensive process for complying with state securities laws. The report details a number of significant advantages associated with Regulation D offerings.

The report does lead one to consider the relative attractiveness of various offering alternatives.

For example, if an issuer (not a reporting company) is prepared to make its offering available only to (verified) accredited investors, the issuer soon will be able to solicit and will not have specific disclosure requirements. Of course, the securities sold in the Rule 506 Regulation D offering will be restricted. No limit on dollars that can be raised.

If the issuer completes one or many such offerings, provided it stays below the new 12g threshold, it will not be required to furnish periodic information to the SEC.

An issuer that is not a reporting company might undertake crowdfunding offerings, through a funding portal or a broker-dealer, to investors meeting certain standards, but then the issuer must comply with certain disclosure requirements in connection with the offering, and also be subject to ongoing albeit limited information requirements. The securities sold in the crowdfunding offering will be restricted. The dollar amounts are small.

Under the JOBS Act, in conjunction with the new Regulation A+ or 3(b)(2), the SEC has discretion to require that the offering document contain audited financials, and that the issuer subsequently make periodic disclosures. Will new 3(b)(2) be appealing? What are the trade-offs for an issuer? If the issuer wants to avoid the costs associated with state blue sky review, then the issuer will either contemporaneously list its securities on a national exchange, or sell to “qualified purchasers.” We don’t yet know who would be classified as a qualified purchaser. The issuer could generally solicit. The issuer will have to comply with specific disclosure requirements in connection with the offering, and, in addition, it will have ongoing disclosure requirements. Of course, the securities sold will not be restricted securities. Is it worth it? Well, the answer to this question will depend largely on the approach taken by the SEC in its rulemaking on 3(b)(2). Will some consideration being given to the fact that there was widespread support for amending Regulation A, even before the JOBS Act had materialized? Will the SEC conduct some cost/benefit analysis and appreciate that if new 3(b)(2) is made sufficiently burdensome it will not provide the useful capital raising alternative that Congress and others had envisioned for emerging companies. Let’s assume the SEC will exercise its discretion to require some additional disclosures. At least, it would make sense to put a premium on clear, concise disclosure, which would be meaningful to investors.

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